I tend to oversimplify complex problems. So do lots of other people. It’s only since I started blogging that I realized how often I did this. That’s because on one day I might passionately believe X was important. On another day it seemed to be all about Y. And a week later Z seemed to be the key to everything. When I’m thinking about one of those things, the others get blotted out of my mind. But blogging leaves a paper trail, so now I realize that I’ve claimed “It all boils down to X,” with at least 10 different Xs.

In recent days three bloggers have tried to get to the core of the policy failure. Matt Yglesias has suggested it all boils down to the zero rate bound, Ryan Avent replied that the key problem is the reluctance of central banks to engineer sharply negative real rates, and Steve Waldman has countered that it’s the political power of older savers that is inhibiting monetary stimulus.

It’s pretty easy to show that none of these answers is adequate, nor is any monocausal explanation I’ve previously offered. So here’s 10 factors that contributed to the “perfect storm,” a list that is itself hardly exhaustive:

1. Yes, Matt’s right that the zero rate bound matters. If the US fed funds rate was currently 2%, and all the macro indicators were exactly as they are now, the Fed would cut its rate target. They are slightly more averse to unconventional stimulus.

3. Steve’s right that the savers lobby plays a role. But I’m a big saver, and I feel that I’d be far better off if money had been much easier in 2008. Partly because tight money badly hurt the values of stocks and risky bonds. And partly because the resulting recession made real rates much lower than they’d be at full employment. It’s not a zero sum game. The “mistake theory” of policy failure is looked down on by sophisticated intellectuals, but if you think (as I do) that 99% if professional economists “got it wrong” in 2008, how much of a stretch is it to assume that the economists at the Fed also got it wrong?

4. Nick Rowe is right that interest rate targeting contributed to the problem by making the Fed “mute” at zero rates. It became harder to signal its future policy intentions.

5. Larry Ball is right that Ben Bernanke’s personal qualities played a role. He favored a more democratic decision process than Greenspan or Volcker, and on average that will get you better decisions. But in this particular case Bernanke’s expertise and instincts are superior to that of the median FOMC voter. And Bernanke’s not the sort of person who would demand that others follow his lead.

6. We are suffering partly because we just happen to have chosen rate targeting rather than level targeting, and prices rather than NGDP.

7. We are in this predicament partly because the public doesn’t understand the concept of “inflation” in the same way as Bernanke does, making for a PR nightmare. When Bernanke announced the need for more inflation in the fall of 2010 (QE2), he meant more demand-side inflation, i.e. higher real incomes for Americans. The public read it as more supply-side inflation, i.e. lower real incomes for Americans. The backlash made the Fed more cautious.

8. We are in this predicament because the median economist believes in intro textbook “liquidity trap” myths, and hence put no pressure on the Fed to stimulate, as they thought the Fed was out of ammo. The Fed usually follows the preferences of the median economist, so this cognitive failure was a really big deal.

9. We are in this predicament partly because the Fed already feels like it has done a lot (as does the profession.) That’s because they never absorbed Bernanke’s 2003 admonition that NGDP growth and inflation are the “only” way to ascertain the stance of monetary policy. They don’t know that ultra-tight money drives NGDP so low that interest rates fall to zero, which makes excess reserves surge. As a result ultra-tight money paradoxically ends up looking like ultra-easy money.

10. And now I’ll end up with a few cheap shots at liberals and conservatives (no single ideology could create such a monumental mess.) In America it’s hard to believe that the opposition of conservatives to monetary stimulus is unrelated to Obama being president. Inflation was higher under Bush, and yet the intensity of conservative Fed bashing was far less. In Northern Europe, conservatives see the crisis as an opportunity to force the southern tier to shape up. In both cases there is a fear that easy money could somehow ‘bail out” failed economy policies. In contrast, American liberals took office in January 2009 with grand dreams that this was a 1933-type opportunity to expand government, just as FDR did. Hence they mostly ignored monetary policy until the GOP took over the House of Representatives.

OK, what have I missed? I bet if you went through my nearly 1500 posts you’d find dozens of other explanations, which I can’t recall right now.

PS. After I wrote this I recalled one more—too much weight on historical inflation numbers (especially in September 2008), not enough weight on targeting the forecast.

Suppose just one individual holds onto their earnings just a little longer than is deemed “justified” by the holy money printers, because he wants to save up to buy a nice car on cash, and everyone else “spends” in a nice, constant, robotic manner over time as good little sheep.

NGDP falls by the amount the individual reduces his spending.

Questions: Why in the world should the Fed reverse/overrule this one individual’s spending and cash holding choice? Why should the money printer be deemed justified in inflating the money supply and giving this money to their banking friends, who are expected to “spend” the additional money and aggrandize themselves? What good is it doing for people in general? What good is it for the guy who holds onto his cash for slightly longer than “justified”? His cash holdings would be reduced in value, thus his plans will be thwarted.

And, if the Fed “should” reverse/overrule this one individual’s spending and cash holding choice, what if instead our man took his accumulating cash and “purchased” a series of massages from his spouse? NGDP would then not fall, so does that mean the Fed isn’t justified in printing money, and so our man can buy the car he wants using cash, and his purchasing power won’t be reduced? He won’t be taxed if he gives cash to someone for some bull$^!t service?

‘The very first survey, going back to last September, asked for responses to the following statement:

“All else equal, the Fed’s new plan to increase the maturity of its Treasury holdings will boost expected real GDP growth for calendar year 2012 by at least one percentage point.”

Exactly 0% of the experts checked “agree” or “strongly agree”. 33% were uncertain and 7% had no opinion. (One refreshing thing about these polls is that the respondent’s have apparently felt free to respond “no opinion” on matters where they are not well informed. Nobody, after all, can be an expert on everything.) When a statement is endorsed by exactly 0% of 41 distinguished experts from across the political spectrum, you can be pretty sure that statement is false.’

To this list I would only add that real economies can only build service economies up to a point, before (desired) wealth creation and productivity means need to be pulled out of the genie bottle and re-examined.

@mf
conflating financial and real savings, again. if someone saves to buy a future car someone else needs to mine steel and build a factory well in advance. money is not real savings, factories are. financial savings is a claim to a share of real savings. the income of the workers and companies building the factory counts in current gdp ad its built. financial savings may, or may not, result in lower gdp.

1. Yes, Matt’s right that the zero rate bound matters. If the US fed funds rate was currently 2%, and all the macro indicators were exactly as they are now, the Fed would cut its rate target. They are slightly more averse to unconventional stimulus.

Zero bounds are inevitable in a continuously distorted real economy that is perceived by money printers as “lack of demand.”

It was unusually low rates that allowed the real estate bubble to form in the first place.

3. Steve’s right that the savers lobby plays a role. But I’m a big saver, and I feel that I’d be far better off if money had been much easier in 2008. Partly because tight money badly hurt the values of stocks and risky bonds. And partly because the resulting recession made real rates much lower than they’d be at full employment. It’s not a zero sum game. The “mistake theory” of policy failure is looked down on by sophisticated intellectuals, but if you think (as I do) that 99% if professional economists “got it wrong” in 2008, how much of a stretch is it to assume that the economists at the Fed also got it wrong?

Looser money would have just hurt the real economy even more by introducing further errors in investment, thus making the value of stocks, bonds, and other accumulated savings even worse in the future.

Stocks and bonds fell so much post 2008 because the Fed loosened post 2001, and distorted the real economy in the meantime. The decline in NGDP post 2008 was just a consequence, and effect. It was not a primary cause. People don’t just decide to stop spending arbitrarily. I see no market monetarists explaining why NGDP fell at all, despite the fact that the Fed never stopped creating new money the whole time. Just like the Keynesians, market monetarists are compelled to treating declines in spending as a mysterious, unexplainable deux ex machina inherent in the market.

4. Nick Rowe is right that interest rate targeting contributed to the problem by making the Fed “mute” at zero rates. It became harder to signal its future policy intentions.

It signalled a target of zero interest rates until 2014, and now 2015.

5. Larry Ball is right that Ben Bernanke’s personal qualities played a role. He favored a more democratic decision process than Greenspan or Volcker, and on average that will get you better decisions. But in this particular case Bernanke’s expertise and instincts are superior to that of the median FOMC voter. And Bernanke’s not the sort of person who would demand that others follow his lead.

That’s impossible Mr. EMH, because the market is efficient. Bernanke does not have superior “expertise”, nor does he have superior “instincts”. He can only just get lucky, like Warren Buffet. He cannot have better predictive ability about the economy, compared to the other FOMC voters, on the basis of any “expertise” or “instincts.” He’s a roulette player that can only just happen to be right based on chance.

6. We are suffering partly because we just happen to have chosen rate targeting rather than level targeting, and prices rather than NGDP.

We are not suffering. We are going through a partial cleansing process that is being held back by continued Fed inflation and artificially low interest rates.

We are only “suffering” the way a hang-over victim “suffers.”

7. We are in this predicament partly because the public doesn’t understand the concept of “inflation” in the same way as Bernanke does, making for a PR nightmare. When Bernanke announced the need for more inflation in the fall of 2010 (QE2), he meant more demand-side inflation, i.e. higher real incomes for Americans. The public read it as more supply-side inflation, i.e. lower real incomes for Americans. The backlash made the Fed more cautious.

More demand side inflation means more money chasing the same supply, which means lower real incomes for those who receive the new money last after prices have already risen.

Supply side inflation? That’s meaningless. Inflation is a monetary concept, it is always on the “demand” side.

No wonder the public, who correctly understood inflation to mean lower purchasing power, took Bernanke’s “inflation” to mean lower purchasing power. And yet here you are saying the public is stupid and Federal Reserve technocrats are intelligent.

If Federal Reserve technocrats are intelligent and the public is stupid, then that is an admission that there are market inefficiency opportunities in the economy. The more intelligent investors can make consistent gains that the stupid investors cannot, thus leading to the more intelligent investors making consistently higher than average gains, as the average is pulled down by the stupid investors.

8. We are in this predicament because the median economist believes in intro textbook “liquidity trap” myths, and hence put no pressure on the Fed to stimulate, as they thought the Fed was out of ammo. The Fed usually follows the preferences of the median economist, so this cognitive failure was a really big deal.

We are in this predicament because the median economist believes in intro textbook “inflation” myths, and hence put pressure on the Fed to print, as they thought the market was out of ammo. The Fed usually follows the preferences of the median economist, so this cognitive failure was a really big deal.

The Fed didn’t let NGDP fall post 2001, and because of that, prevented the investment errors from being corrected, and introduced new errors besides, which then caused the 2008 crisis.

9. We are in this predicament partly because the Fed already feels like it has done a lot (as does the profession.) That’s because they never absorbed Bernanke’s 2003 admonition that NGDP growth and inflation are the “only” way to ascertain the stance of monetary policy. They don’t know that ultra-tight money drives NGDP so low that interest rates fall to zero, which makes excess reserves surge. As a result ultra-tight money paradoxically ends up looking like ultra-easy money.

Interest rates didn’t fall to zero. The rates on AAA corporate bonds have remained above 0%, and are now 4%.

If you mean the Fed funds rate, well that’s because the Fed targets it.

If you mean short term treasury rates, well that’s partly because the Fed buys them at above market prices, i.e. the initial buyers of the treasuries pay higher prices because they know the Fed will buy them at those higher prices, and the Fed made good by buying 61% of all the issued treasuries in 2011, and partly because treasuries are deemed much safer assets, but not because of falling NGDP, but because the new composition of NGDP made existing investments unprofitable. It doesn’t help indebted firms that while less money is spent on their goods, more money is spent elsewhere on other goods. Their debt is still valued less regardless of NGDP.

10. And now I’ll end up with a few cheap shots at liberals and conservatives (no single ideology could create such a monumental mess.) In America it’s hard to believe that the opposition of conservatives to monetary stimulus is unrelated to Obama being president. Inflation was higher under Bush, and yet the intensity of conservative Fed bashing was far less. In Northern Europe, conservatives see the crisis as an opportunity to force the southern tier to shape up. In both cases there is a fear that easy money could somehow ‘bail out” failed economy policies. In contrast, American liberals took office in January 2009 with grand dreams that this was a 1933-type opportunity to expand government, just as FDR did. Hence they mostly ignored monetary policy until the GOP took over the House of Representatives.

I’ll add another cheap shot. The correction we’re in would not have been necessary if monetarists heeded the warnings of free market economists that a policy of inflation inevitably requires a correction period in the future. The collapse in 2008 was so large because the Fed has not allowed a true correction in the market since at least 1971. Every time a sniff of a depression approached, they printed their way out of it, sometimes more, sometimes less, but always positive. That is creating larger and larger busts over time. The next bust is going to be the result of the Fed failing to allow the corrections that were desperately needed post 2008 to take place, and while you market monetarists are yelping for more destructive inflation, as if inflation doesn’t have any real effects on the economy apart from consumer and saver preferences, while you yelp for the Fed to monetize even more government debt, you’re just setting the economy up for another crash, one even larger than the last one.

It’s pretty easy to show that none of these answers is adequate, nor is any monocausal explanation I’ve previously offered. So here’s 10 factors that contributed to the “perfect storm,” a list that is itself hardly exhaustive:

There is a monocausal explanation. It’s the prevailing belief that altruism and universals must trump egoism and particulars. You and other monetarists want to control egos. You say you prefer to abolish the Fed, but you fail to see how your own NGDP targeting cannot solve the inherent problem of the Fed. The problem isn’t the type of Fed policy. The problem is the Fed itself. A program where the Fed controls the allegedly single “outcome” of individual spending and cash holding preferences, is doomed to fail. Individual egos will continually antagonize and continually act to purge the system clean of cancerous agencies seeking to overrule it.

The price system, and economic calculation, is not controllable by ANY individual. One of the most important aspects of the price system that so many monetarists don’t understand is that the price system works best when nobody stands as King and consciously controls it. Various statistics like “aggregate demand” don’t need a single conciousness controlling it. Those who favor ACTUALLY abolishing central banks aren’t saying that individuals in economic competition will “take the place” of the Fed and become consciously aware of “aggregate demand”, as if a given individual will control “the price level”, and “purchasing power of money”, etc. No, the price system is a concept that transcends a single ego trying to control it.

The price system is a reflection of multiple egos working selfishly and individually for their own respective interests, and the resulting “aggregate” statistics like “aggregate demand”, “price levels”, “aggregate employment”, “aggregate spending”, cannot have a single ego controlling it “on behalf of” all other egos. Any attempt by one ego to overrule the outcome of a society of multiple egos, will ALWAYS face antagonism, and their efforts thwarted. The thwarted efforts will be observable to you and I as deflation, depressions, unemployment, etc. It’s untenable.

There is a natural order among egos devoid of collectivist institutions ruled by single egos trying to control all other egos, and market monetarists, despite their free market rhetoric, are completely clueless about this.

Since inflation distorts the system of economic calculation, it will never “work.” The only thing we have to observe in this world is various inflation systems, some going down the road to ruin faster than others. Since economics has been almost completely hijacked by positivists, most economists believe that the only valid subject matter is observable, and so they cannot help but believe that those going down the road to ruin slower, are somehow the optimal ideals of “monetary policy.”

It’s like someone watching those at McDonald’s dying off faster than those eating at Burger King, then concluding that Burger King is optimal food. Then, to make it hilarious, that someone then says that while they admit that eating at Burger King isn’t optimal, and is just the best food available, they nevertheless say they can’t understand why they see so many people as unhealthy and feeling like garbage all the time. Then they believe it must be because of too much McDonalds and not enough Burger King.

3. Steve’s right that the savers lobby plays a role. But I’m a big saver, and I feel that I’d be far better off if money had been much easier in 2008. Partly because tight money badly hurt the values of stocks and risky bonds. And partly because the resulting recession made real rates much lower than they’d be at full employment. It’s not a zero sum game. The “mistake theory” of policy failure is looked down on by sophisticated intellectuals, but if you think (as I do) that 99% if professional economists “got it wrong” in 2008, how much of a stretch is it to assume that the economists at the Fed also got it wrong?

Alright, I feel like I have to respond to this point. Not that you are really making this point, but I’m tired of hearing people hypothesize about what bond traders want (and the savers lobby they serve). Bond traders don’t care about inflation, they only care about changes in inflation because it raises long interest rates (and lowers prices for existing bonds). Bond traders care a hell of a lot more about defaults and credit quality; these events are non-linear and make risk management exponentially more difficult, which makes returns uncertain. Any bond trader would gladly take a lump of 1 percentage point increase in inflation if it decreased the likelihood of bond issuer defaults.

I normally really like Ryan’s blogging, but I think the focus on negative real interest rates is off the mark. It’s a chicken-egg problem. The need for negative real rates today exists only because NGDP is so far behind. Policy makes should not be trying to hit equilibrium by using clever schemes to drive real rates to the negative market clearing level, they should shift the curve so that the market clearing rate is positive.

I didn’t conflate them a first time, how could I have done it “again”?

if someone saves to buy a future car someone else needs to mine steel and build a factory well in advance.

If someone reduces their present consumption, that would, in an unhampered monetary and price system, send signals to investors that consumers desire more future consumption and less present consumption. It would do this by making the profitability of higher order productive stages relatively more profitable than consumer goods, in way consistent with the individual’s cash holding and consumption pattern changes.

That would RELEASE factors of production, resources and labor, from present consumer goods production, and make them available for use in the higher order productive stages like steel and factory production. After all, investors chase profits. They don’t care if relative profits increase in capital goods and decrease in consumer goods. They will invest where profits can be made.

And wouldn’t you know it? The relative profit changes that are in line with the specific consumer cash holding and preference changes, the shifting of resources away from present consumption and towards future consumption, is exactly in line with the individual’s desire to reduce their present consumption, accumulate cash, and then purchase a future consumer good.

What inflation does is distort this signalling and profit change process. With inflation, there is an arbitrary increase in profits somewhere in the economy that is not in line with the specific cash holding and consumption change of the consumer. The signal of the consumer’s behavior is distorted by a new signal from the inflation. Just imagine. An individual in Des Moines decides to reduce his consumption and accumulate cash to buy a car, and in response, the Fed prints money and buys a Treasury bill from a bank in New York, after which the banker does what he wants with the money, like speculate in real estate in Nevada, where NO such change in cash holding and consumption patterns arose from the part of consumers in Nevada.

In other words, the inflation, while it does “maintain country wide NGDP”, nevertheless distorts the real economy.

How in the friggin heck is this a solution? It’s laughably moronic.

money is not real savings, factories are. financial savings is a claim to a share of real savings. the income of the workers and companies building the factory counts in current gdp ad its built. financial savings may, or may not, result in lower gdp.

“In America it’s hard to believe that the opposition of conservatives to monetary stimulus is unrelated to Obama being president.”

Instead of “Obama” in that sentence, I would say “a Democrat”. I think it’s partisan, not personal. It would have been the same with Hilary Clinton or Joe Biden. But I agree with your main point. I think it’s referred to as confirmation bias.

I like to imagine an alternate scenario, where Obama practices Rubinomics in his first year and passes a major deficit reduction bill and no stimulus or health care bill, saying we can’t afford it because of the crisis. And he pressures Bernanke to raise NDGP to the pre-crisis trend as a condition of reappointment. Then he appoints Christina Romer to the Fed Board, and finds some Chicago school trained economist to join her, maybe someone from Bentley. By now, the economy would be healthy and Obama’s approval ratings would be above 60%.

Comparing gold to 1982 Bordeaux, it’s easily seen that gold is MORE divisible, MORE durable, and MORE highly valued per unit than 1982 Bordeaux. So gold will better serve as money in the free market than 1982 Bordeaux.

Of course, what fiat bug morons never bother to do is use their own garbage logic on fiat money itself. Why cotton and linen? Why not cheese? “You can’t eat” [cotton or linen].

yep, lots and lots of things. the good thing about blogging is that it forces one to be succinct. the bad thing is that it forces one to be succinct.

honestly, sure it has some drawbacks, but it brings out into the open debates that would only go on in dept seminars. if one has not broken something probably one is not swinging the hammer hard enough.

The person by spending less now is freeing up more resources now. This resources can be used to produce capital goods now, which will hope produce his car later.

By accumulting money now, he is lending more to the money issuer. The money issuer can borrow more money now, and, being a financial intermediary, can lend that money out. This will fund more capital goods, helping to produce that extra car later.

Nominal GDP just stays the same, there is a shift in the allocation of resources. When he wants to spend his moeny later, then total lending will fall again. Of all the poeple paying back loans that day, there will be slightly fewer new loans made.

The person by spending less now is freeing up more resources now. This resources can be used to produce capital goods now, which will hope produce his car later.

Which resources? Clearly since a policy of inflation introduces arbitrary cash holding and spending patterns elsewhere in the economy that are not the product of someone in Des Moines reducing their consumption and accumulating cash, it would be silly to say that inflation is NOT putting the economy on a path that is in line with real consumer preference changes. Nobody changed their preferences in Nevada that would justify speculating on real estate on account of inflation.

By accumulting money now, he is lending more to the money issuer.

No he isn’t. By accumulating more cash now, he is not lending any money. Cash holding is not cash lending.

The money issuer can borrow more money now, and, being a financial intermediary, can lend that money out. This will fund more capital goods, helping to produce that extra car later.

So where’s the inflation justification again?

Nominal GDP just stays the same, there is a shift in the allocation of resources. When he wants to spend his moeny later, then total lending will fall again. Of all the poeple paying back loans that day, there will be slightly fewer new loans made.

You’re fallaciously presuming that accumulating cash is the same thing as lending more, which is actually just a destructive side effect of fractional reserve banking, and you’re ignoring the fact that this “response” by the bank is not in line with and is not justified by the cash holding and consumption preference change.

There is a difference between the effects of someone reducing their consumption and accumulating cash, and the effects of a bank issuing more credit because their client’s cash balances are higher for longer.

An expansion of credit arbitrarily increases demand and hence profitability of some project somewhere. A bank that issues credit can go to pretty much anything, totally apart from any changes in real consumer preference changes in those areas.

A bank that issues more credit that results in increased present demand for houses cannot possibly be considered in line with someone in Des Moines who reduces their present consumption to accumulate cash to buy future consumer goods. The economy gets all warped when that happens.

Only if the Fed does not print money at all, will the full effects of our man’s actions in Des Moines get properly communicated to investors around the country. Investors around the country will see the only change to be a reduction in the particular consumption in Des Moines, and that’s it. They won’t see any change in Nevada. But a policy of credit expansion, to “counter-act” the fall in consumption demand in Des Moines, leads to an arbitrary increase in profitability, and hence cash holding and consumption change elsewhere in the economy.

You can’t “mimic” what happens in a free market by central banks printing money arbitrarily and giving it to banks arbitrarily who then spend or loan it out arbitrarily.

It has to be a result of specific changes in the economy, and the only way the price system can do this is without inflation and without credit expansion.

Clearly since a policy of inflation introduces arbitrary cash holding and spending patterns elsewhere in the economy that are not the product of someone in Des Moines reducing their consumption and accumulating cash, it would be silly to say that inflation is NOT putting the economy on a path that is in line with real consumer preference changes.

should read

Clearly since a policy of inflation introduces arbitrary cash holding and spending patterns elsewhere in the economy that are not the product of someone in Des Moines reducing their consumption and accumulating cash, it would be silly to say that inflation is NOT putting the economy on a path that is not in line with real consumer preference changes.

The money issuer can borrow more money now, and, being a financial intermediary, can lend that money out. This will fund more capital goods, helping to produce that extra car later.

Banks don’t just lend money out to fund capital goods. Banks lend to consumers as well. You can’t say that an increase in capital goods lending will necessarily result.

And even if banks did expand more loans that fund capital goods, that lending itself will bring about a change in profitability in the economy totally apart from the preference change of the man in Des Moines. The resulting effects will not be a result of real consumer preference changes elsewhere either.

At least in a world without inflation, the fall in consumer spending and accumulating cash balances will only bring about a change in profitability consistent with his own actions, and so investors across the country will be able to accommodate the effects of that one person’s behavior. With credit expansion on the other hand, relative profitability is changed without any change in real consumer preference changes like the man in Des Moines.

yep, we are all against higher trend inflation. fortunately, ngdp targeting does not produce it.

*Sigh*, as the quality of the debate continues to be this low, I sometimes debate whether or not you deserve what you get.

It’s not about “trend inflation” of “price levels”, dwb. It’s about economic calculation.

Furthermore, NGDP of 5% does generate higher “trend inflation”, regardless of if one defines inflation as rising prices or increase in the money supply.

Any real growth rate below 5% in the presence of 5% NGDP targeting will result in increasing prices, and requires an increasing money supply.

But this is besides the point I am making. The point is not what the price level is, or what aggregate spending is, or any other aggregate that inevitably masks the more detailed process of economic coordination in the price system.

If one individual reduces their consumption and accumulates cash, and the Fed or a commercial bank responds to this by increasing the money supply, or expanding loans, which results in an arbitrary change in relative profitability in the economy (by “arbitrary” I mean a change brought about not as a direct result of the individual’s preference changes, but rather as a result of the preferences of the person who initially receives the new money). Even though the result may be an unchanged “NGDP”, or unchanged “aggregate demand”, or unchanged “average price levels”, the inflation itself changes the economy in a way totally apart from the changed preferences of the individual in question, and as a result, the pricing signals are altered in a way that is NOT a direct result of that individual’s preference changes.

Instead of the economy’s profitability structure being altered because of this one individual’s behavior, there is an additional profitability structure change brought about because of the inflation and/or credit expansion. Where that inflation goes, and the relative profitability changes that result, will not be in line with the change from the individual’s new behavior. It is irreplaceable. It cannot be mimicked. It is unique.

Just step back and think how absurd it is to believe that should an individual reduce their consumption and accumulate cash in Des Moines, that the Fed printing money and giving it to a bank in NY, who will do who knows what with it, can possibly produce the same exact profitability structure change, compared to if the Fed did not print that money, and the only monetary change that occurred was due to the individual in Des Moines.

“if someone saves to buy a future car someone else needs to mine steel and build a factory well in advance.

If someone reduces their present consumption, that would, in an unhampered monetary and price system, send signals to investors that consumers desire more future consumption and less present consumption. It would do this by making the profitability of higher order productive stages relatively more profitable than consumer goods, in way consistent with the individual’s cash holding and consumption pattern changes.”

No it wouldn’t, for the same reason as the pattern of allocation of resources wouldn’t change if everyone reduced their aggregate spending by $5. Of course that would cause a recession, which would lead to second-order effects. My hoarding of thousands of dollars to buy a car will only shift resources away from the entire line of spending associated with Ford Focuses or whatever.

MF, I think what you’re talking about is Selgin’s productivity norm. That’s supply-side deflation, which Scott also thinks is good. But demand-side inflation is bad, even when wages are perfectly flexible.

Actually supply side deflation is also bad, in that case. But demand-side deflation is especially bad with sticky nominal debts and wages. Irving Fisher understood this. Keynes only obfuscated in the GT.

“If someone reduces their present consumption, that would, in an unhampered monetary and price system, send signals to investors that consumers desire more future consumption and less present consumption. It would do this by making the profitability of higher order productive stages relatively more profitable than consumer goods, in way consistent with the individual’s cash holding and consumption pattern changes.”

No it wouldn’t, for the same reason as the pattern of allocation of resources wouldn’t change if everyone reduced their aggregate spending by $5.

But it would change if people reduced their “aggregate spending” by only reducing their consumption spending. In my example, there is only one individual consuming less, and accumulating cash. That WOULD alter the relative profitability structure. It would make those particular consumer goods relatively less profitable, and it would make capital goods relatively more profitable than consumer goods.

Of course that would cause a recession, which would lead to second-order effects.

What you call a recession, I call a correction. What you believe is rightfully entitled producers and workers, I say is not entitles to them at all, and they have to suffer if they invest and produce what consumers don’t want in the present.

If consumers no longer want to scoop up horse manure, and would rather drive in cars, then producers and workers of horse carriages should lose their careers in horse carriage making, and find something else that earns a return.

My hoarding of thousands of dollars to buy a car will only shift resources away from the entire line of spending associated with Ford Focuses or whatever.

In the present, yes, it would. But that’s what should happen, because the consumer WANTS that. Are you so hopped up on wanting to control other people’s lives that you willingly, happily, and with enthusiasm, call to overrule the effects of consumer preference on business activity?

MF, I think what you’re talking about is Selgin’s productivity norm. That’s supply-side deflation, which Scott also thinks is good. But demand-side inflation is bad, even when wages are perfectly flexible.

Sorry, demand-side deflation.

No, it’s supply side deflation. More goods sold for lower prices in a given demand.

FINANCIAL REPRESSION!!! WE’RE ALL BEING CHEATED OF OUT GOD GIVEN RIGHT TO HIGH GUARANTEED REAL RETURNS!!!

Oh so you are against inflation then? The initial receivers of newly created money gain instant real returns, because their nominal incomes go up before prices have a chance to rise on account of that new money percolating throughout the economy.

Oh that’s right, you only want SOME “powerful” people to earn guaranteed real returns. Not the average Joe who is to be exploited.

MF: Selgin-style supply side deflation has the property you described, changing values of consumer vs producer goods. Demand side deflation doesn’t. When people buy less Fords, but don’t buy any more of anything else, not even bonds, and the money multiplier is constant – then Ford Motor Co. also cuts back on spending, and the only aggregate change in spending composition is away from the Ford line of production and consumption. Now this wouldn’t be quite so bad if the price level could adjust so that the markets all cleared at a lower level of aggregate spending. But it doesn’t.

If Fords comprise 0.1% of NGDP (say), and people stop buying them, (without engaging in real saving or buying anyhing else) then the price level has to fall by 0.1% in order to prevent loss of output and employment.

I’m immensely encouraged that we actually seem to be making progress here. This is incredible considering how long some of these disputes have lasted and how acrimonious they have been.

To add to the above, there is this from Tyler Cowen:

” Just to review briefly, I find the most plausible structural interpretations of the recent downturn to be based in the “we thought we were wealthier than we were” mechanism, leading to excess enthusiasm, excess leverage, and an eventual series of painful contractions, both AS and AD-driven, to correct the previous mistakes.”

As you can see, this time it was, indeed different. This is the biggest shock since the series begins in 1947.

We tend to mentally convert our net worth into goods and services at current prices, with an allowance for inflation. Now losing an appreciable part of your net worth would be fine if all prices adjusted down to compensate, but that isn’t going to happen.

Furthermore we suspect that if we all added our mental estimates together in terms of actual goods and services, the claims would exceed the available supply. This isn’t a price problem. There just isn’t enough stuff. There never was. Even if the economy was going full blast, we suspect there still wouldn’t be enough stuff.

This is certainly the case in Greece. They thought they were going to retire at 55. Even if the economy had stayed on its supposed course, this couldn’t ever have happened.

But “those [insert expletives of choice here] stole my retirement” is pretty strong stuff, particularly if it appears that everybody else is doing fine. The truth is the neighbors are just a little later getting the point – Not only can’t you put a quart in a pint pot, but you can’t get one out of one either – not even from a financial system magic pot.

People are preparing to retire; the chickens are coming home to roost.

Why are you calling it “Selgin-style” deflation? This kind of deflation has been known since the classicals.

Demand side deflation doesn’t. When people buy less Fords, but don’t buy any more of anything else, not even bonds, and the money multiplier is constant – then Ford Motor Co. also cuts back on spending, and the only aggregate change in spending composition is away from the Ford line of production and consumption.

No, this is false. The composition of spending DOES change. It changes because relative profitability changes. When people buy fewer Fords, the the relative profitability of other car companies rises, and the relative profitability of capital goods in general rises. Remember, a fall in spending on Fords reduces the profitability of Fords, and that increases the relative profitability of everything else not Fords.

A reduction in spending on Fords doesn’t have to be matched by an equivalent increase in nominal spending on other things, before the profitability structure changes and before relative spending changes.

Now this wouldn’t be quite so bad if the price level could adjust so that the markets all cleared at a lower level of aggregate spending. But it doesn’t.

Prices do adjust, if you only stopped treating price changes as having to adjust instantaneously before you believe inflation in Nevada is all of a sudden justified.

Otherwise monetary policy has to remedy the spending deficiency. Or fiscal policy (if the Fed holds the money supply constant), but that generally does more harm than good.

It is only a “deficiency” if you start with the fallacious notion that aggregate spending must be controlled by a single consciousness. It is only a “deficiency” if you start with the fallacious notion that aggregate spending ought not fall.

It makes no sense to call for inflation, which arbitrarily changes the profitability structure of the economy, in response to specific instances of reduced spending in specific locations, for specific reasons, for specific goods.

dwb:

yep, i agree inflation distorts relative prices. fortunately, an ngdp target of between 3-5% would not result in material trend inflation.

I already showed this to be false, to the extent that real productivity is lower than 5%. Also, and more importantly, again, I am not talking about “price levels”, or “trend inflation”. I am talking about relative prices and relative profitability and the structure of production.

If you admit that inflation alters relative prices, then you must admit that it changes relative profits away from what is generated by consumer preference changes, and because of that, NGDP targeting distorts the economy, and thus throws the economy onto a path that requires future correction.

Optimal according to what? According to who? Who cares if average prices rise or fall? My argument transcends crude price level estimates, and concerns the specific prices in specific locations for specific goods paid for by specific people only. It has nothing to do with any ridiculous aggregation of trying to find a single magical value representing the price of sandwiches in upper east NY last Tuesday with the price of a house in Phoenix last month.

Not only do new goods appear all the time, but old goods disappear. A price level is a chimera. Grounding inflation “targeting on a price level is insane.

Even if we used the crude price level conceptualization, if real productivity is anything less than 5%, then prices will rise on average should nominal spending be rising at 5%. This is because prices are a function of supply and demand, and should demand growth outstrip supply growth, then prices will rise.

You say a demand growth of 3-5% won’t result in rising average prices, but since when it real productivity that high? In the US, real productivity according to the St Louis Fed is barely above zero, and that is the government’s reported number. Imagine the actual number. It’s probably negative.

You’ve listed 10 things and not gotten to something I think of as a key element of the Sumnerian Analytic Apparatus: when the US economy recovers, the supply/demand situation in oil generates both rapid gas price increases and phony US inflation, limiting the inclination of US policy-makers to bring above a swifter recovery. This you have a negative supply shock (oil price increases) not leading to a more expansionary policy, but to a more contractionary policy.

This is related to point 7, of course, but you don’t mention the price of oil specifically.

Or is oil not really such an important part of the story? My thinking is often unsound….

If Fords comprise 0.1% of NGDP (say), and people stop buying them, (without engaging in real saving or buying anyhing else) then the price level has to fall by 0.1% in order to prevent loss of output and employment.

First, you’re ignoring the fact that output and employment do not depend on “aggregate demand”. They both depends on saving and investment. If consumer spending falls, then investors will reprice factors of production to be lower, just like they reprice factors of production to be higher when consumer demand increases.

Second, the Fed should not be in the business of micromanaging the economy’s output or employment.

Third, why can’t Ford simply reduce their demand for factors of production? The price level doesn’t have to fall by 0.1%. Ford can just spend less on resources and labor, and those resources and labor can be absorbed elsewhere in the economy, exactly like you presume is the case when aggregate demand stays the same and there is a reduction in demand for some goods and an increase in demand for other goods. The companies that experience a drop in demand will release resources and labor for other companies to purchase.

Population growth, and any other factor that can possibly affect supply, is subsumed under real productivity.

To the extent that real productivity is less than 5%, which of course includes the effects of population growth, should nominal spending grow at 5%, this will result in increasing prices, regardless of what population size or growth exists.

Alright, I won’t then. But he’s the one who advocates it as desirable.

“When people buy fewer Fords, the the relative profitability of other car companies rises …”

Yes.

“… and the relative profitability of capital goods in general rises.”

No.

“Remember, a fall in spending on Fords reduces the profitability of Fords, and that increases the relative profitability of everything else not Fords.”

Go back to the circular flow of income. Households are spending on consumer goods. Spending on consumer goods becomes revenue to the firms that make them. These revenues are spent on firm inputs. (Actually, the inputs were already mostly paid for by borrowing, and the revenues now largely cover debts and interest.) The input producers include households supplying labor, and firms supplying capital goods and other intermediate goods. The spending on labor services becomes income to the households that supply them. The spending on the firms becomes revenue, which pays for their inputs, which include labor and capital goods… until eventually all spending is received as income by households. And then those households spend again, which continues until the circular flow ends as all dollars are held. Of course dollars that are held are also spent eventually, which begins the next circular flow.

Now, what happens when people buy less Fords? Let’s assume the price level doesn’t adjust. Output of the Ford Motor Co. falls, of course. But so does the output of the suppliers of labor and capital goods to Ford. So workers are unemployed at Ford. But also, the workers at the firms supplying to Ford are unemployed. But also, the workers at the firms supplying to the firms that supply to Ford are unemployed. And all the households in this line of spending receive less income. Meanwhile, first-round spending on other consumer goods continues unabated. So does spending on all their inputs. So the income from that line of spending still reaches households. But with the price level stuck, the input providers not being paid by the Ford line of spending are not paid by anyone else. So aggregate nominal income to households falls. So aggregate real income to households falls. So the next round of spending on all consumer goods is lower. So the next round of all spending on all capital goods is lower. So the next round of income to households is lower. And so on.

Notice how, the drop in spending on Fords reduced output of both consumer and capital goods. So there is no reason to suppose that “the relative profitability of capital goods” rises. In fact the absolute profitability of both consumer and producer goods falls, whilst the relative profitability is the same. (Producer goods include capital goods as well as other non-durable intermediate inputs – materials, or circulating capital.) Again, we’re assuming a sticky price level.

Now, what if prices were flexible? In that case, spending on Fords falls. And Ford still spends less on its inputs. The workers at its factories will be unemployed, though reemployed elsewhere if they accept lower wages. We assumed that people have lowered their real demand for Fords; i.e. they want to hold money balances instead of Fords at any price of Fords. So Ford suffers. But the providers of intermediate goods to Ford (materials and capital) can still sell all their output, by lowering their prices. In this way, surplus resources are absorbed into the rest of the economy. Meanwhile, spending on other consumer goods continues unabated, as does spending on the corresponding producer goods. But because producer goods are cheaper (since prices were flexible), the firms producing all the other consumer goods buy the surplus of producer goods, and there is no more unemployment. Eventually, all the spending is received by households. Because the households buying Fords spent less, the aggregate quantity of dollars received by households in the first round of spending falls. So nominal income falls. But because prices are flexible, all producers of the next rounf of consumer and capital goods being spent on can lower their prices slightly, to absorb all the demand. If nominal income from the first round falls by 0.1%, then spending on all goods falls by 0.1%. But if the price level also falls by 0.1%, then real income stays constant. The budget constraint of households shifts out by as much as it shifts in, with no change in the slope. So the composition of the second round of spending is exactly the same as it would have been. This is not surprising: If the govt. announced that each coin would be worth half its face value, you’d expect prices to fall in half, and everyone to buy the exact same things, wouldn’t you? Only the numbers on the value of the transactions have changed. But “relative spending” does not change. Ford drops out of the first round of consumer good producers. And the lower revenue of first round consumer good producers is now shared among the same number of producer good producers, so the revenues of these firms is lower. But “relative profitability” shifts slightly in favor of consumer goods, not producer goods. This higher relative profitability will eventually induce the entry of a new consumer goods provider to replace Ford.

“A reduction in spending on Fords doesn’t have to be matched by an equivalent increase in nominal spending on other things, before the profitability structure changes and before relative spending changes.”

If prices are sticky, then producers of both consumer and producer goods receive less spending and profits relative to others. If they are flexible, then relative spending does not change between producer and consumer goods (at all), or between producer goods and other producer goods (very much; obviously other companies will buy producer goods in different proportions than Ford did, so some prices will fall more than others). Relative spending between consumer goods producers shifts away from Ford and towards other consumer goods producers. As for profitability, the profits from consumer goods are now split amongst fewer consumer goods firms, whilst the profits from producer goods are split amongst the same firms. Each consumer goods firm makes more profits, whilst producer goods firms make the same real profits on average. So although the ratio of consumer goods profits to producer goods profits stays the same, consumer goods firms are relatively more profitable than producer goods firms.

“Prices do adjust, if you only stopped treating price changes as having to adjust instantaneously …”

No, they can take several years.

“… output and employment do not depend on “aggregate demand”. They both depends on saving and investment.”

Neither of which increases in real terms to compensate the fall in real consumption. Indeed both saving and investment fall as soon as the markets anticipate recession.

“If consumer spending falls, then investors will reprice factors of production to be lower … “

No they won’t, because prices (particularly wages) are sticky downwards.

“… why can’t Ford simply reduce their demand for factors of production? The price level doesn’t have to fall by 0.1%. Ford can just spend less on resources and labor, and those resources and labor can be absorbed elsewhere in the economy, …”

That’s exactly what they will do. And what happens when the demand curve shifts to the left, whilst the supply curve doesn’t? That’s right, equilibrium price falls. But if the actual price level doesn’t fall to equilibrium, there will be surplus resources which won’t be absorbed elsewhere.

“… exactly like you presume is the case when aggregate demand stays the same and there is a reduction in demand for some goods and an increase in demand for other goods. The companies that experience a drop in demand will release resources and labor for other companies to purchase.”

See the difference in this case? The demand curves of some buyers shift left whilst other demand curves shift right by the same total amount, so the price doesn’t fall. Yes of course when demand falls this “releases resources”, that’s what unemployment is all about. But the “other companies to purchase” doesn’t happen on its own, because by assumption markets were in equilibrium beforehand (markets were clearing beforehand), and everyone was already buying all they wanted to buy at the given prices. The surplus resources can be absorbed, but only if prices fall. The perfect free-market economy which your Austrian theory tries to describe presumes flexible prices for everything, including labor. In that case you would be right, the economy adjusts to all changes in individual decisions on its own. But free-market economists have always realised (including Fisher and Friedman) that that is an empirically unrealistic assumption. Hence aggregate spending matters, particularly on the downside.

Of course, I have ignored the fact that not every drop in aggregate spending is recessionary. Firms are not stupid; they prepare for fluctuations in nominal spending. They produce at the average level of output demanded, known misleadingly as “potential output”. So when there is less demand in one year, firms accumulate inventories, expecting to sell more in the next. Only when there is a massive accumulation of inventories and a clear decline in consumer confidence (again, if the price level were flexible no one would care about “consumer confidence”) do firms start laying off workers.

I think it will help you to keep the simple AS/AD model (levels, not growth rates) in mind as you think about these questions. Treat it as a metaphor if you like, but it really clarifies your thinking.

MF writes, “Population growth, and any other factor that can possibly affect supply, is subsumed under real productivity.”

Not in my argument: if I hadn’t wanted to distinguish productivity gains strictly understood from gains due to increased factor input, I wouldn’t have used the expression “productivity norm.”

MF is right about arguments for deflation going back to the classics. I dare say, though, that he knows it because I wrote about the fact both in my ’97 pamphlet and in earlier HOPE papers! When I started my productivity norm work in the mid-1980s, nobody was writing about “good” deflation, nobody believed in any such thing, and nobody remembered those economists who had believed in it in the past.

Maybe because you don’t understand it? In your example the decision to save by one person doesn’t reduce NGDP, it simply means the money finances the investment part of NGDP, not the consumption part.

Joe, Actually that’s not necessarily true. It still depends on the Fed reaction function. If their policy is to target inflation at 1% once rates hit zero, the fiscal multiplier might still be zero. I have always admitted that you might be right, but it’s not clear.

Patrick, I agree in this case, but the consensus of economists can be wrong, and has been on occasion.

Morgan. You’d still need lower rates for a while, even with optimal housing policies.

Becky, I didn’t follow that.

Kailer, Cute.

Cthorm, you said;

“The need for negative real rates today exists only because NGDP is so far behind. Policy makes should not be trying to hit equilibrium by using clever schemes to drive real rates to the negative market clearing level, they should shift the curve so that the market clearing rate is positive.”

Good point.

Negation, I agree it was because the Dems are in office, not Obama personally. And I like your alternate reality too.

dwb, Good observation.

Thanks Ben.

Saturos, Yes, Arnold has a good observation there.

Steve, Do you favor point three because you are Steve Waldman?

Peter N, You said;

“We tend to mentally convert our net worth into goods and services at current prices, with an allowance for inflation. Now losing an appreciable part of your net worth would be fine if all prices adjusted down to compensate, but that isn’t going to happen.”

It would be fine if the Fed kept NGDP growing at 5%, even if wages and prices are sticky.

It would be fine if the Fed kept NGDP growing at 5%, even if wages and prices are sticky.”

I’m not so sure. If this was your ordinary severe recession, even a balance sheet one, I might agree, a lot of unpleasant trends have converged.

First of all, the perception of lost wealth will be hard to counteract. It’s really not a monetary problem. Think of a time share where management has sold weeks to 65 people. No price adjustment is going make a year have 65 weeks. You can, of course, raise the price until 13 people dropped out. This “solution” isn’t going to make any of the people very happy, either the 52 pay mores or the 13 no vacations.

It isn’t that we feel we’ve been promised more money, rather we feel we’ve been promised more stuff. If you want to get fancy this is a result of decoupling asset inflation from goods inflation. In retrospect this looks to have been a bad idea.

So, not sticky prices or sticky wages, but sticky expectations, and anger at those whose promises led to them.

Now if we could get Chinese levels of real GDP growth along with Chinese levels of patience, we might keep everybody happy.

The one absolutely vital thing to do is to permit a lot more immigration, and favor those with the most to contribute.

In another 20 years 95% of US adults will be unemployable for productive jobs (as opposed to waiters in very expensive restaurants, psychic advisers, art critics… We’ll all be on the spaceship with the telephone sanitizers), and we’ll have a different problem, if we can make it that far.

I’d like to know what you think of the FRED charts I posted. How much faster than GDP can net worth grow, and for how long. I recall something about things that can’t go on forever, don’t. The rate from 1951-1981 was 3 times GDP, then its quickly switched to 5 times until the recent debacles. Was this deregulation?

You’ll also see that the latest hit to net worth was by far the largest since 1951 (the series start there), and after rising 150% from 1981-1999, it’s back at 1999 levels. We have nothing to show for 12 years work (yes, of course, there are large utility gains from substitution).

??? That’s funny, considering how I have corrected so many incorrect claims concerning NGDP.

In your example the decision to save by one person doesn’t reduce NGDP, it simply means the money finances the investment part of NGDP, not the consumption part.

No, that isn’t true. In my example, the consumer HOARDS cash over time by reducing their consumption spending. It does reduce NGDP because while there is a drop in consumption spending, the individual does not equivalently increase his investment. He simply accumulates cash that he otherwise would have spent. So aggregate spending does fall.

I apologize for this I am sure somewhat dumb question, but could someone quickly give me a straight forward definition of supply vs demand side inflation. I am assuming supply side means rising costs for firms to produce. But not entirely sure how I could describe demand side to someone with little economic knowledge.

MF writes, “Population growth, and any other factor that can possibly affect supply, is subsumed under real productivity.”

Not in my argument: if I hadn’t wanted to distinguish productivity gains strictly understood from gains due to increased factor input, I wouldn’t have used the expression “productivity norm.”

What you call “productivity norm” is the ONLY source or mechanism by which increased output, or productivity gains, are manifested. Population growth on its own does not do it. Sure, population growth typically does increase overall productivity, but that is just realizing that the productivity gains are on the side of supply growth, not population growth. If we assume a population growth has no effect on supply growth, then output won’t increase and prices won’t fall. The ONLY factor that determines output prices is demand for them, and the supply of them. That’s it. Every other phenomena, be it population growth, technological progress, etc, if they are going to affect prices, MUST operate to change either supply or demand or both. If they do not, then prices will not change.

MF is right about arguments for deflation going back to the classics. I dare say, though, that he knows it because I wrote about the fact both in my ’97 pamphlet and in earlier HOPE papers! When I started my productivity norm work in the mid-1980s, nobody was writing about “good” deflation, nobody believed in any such thing, and nobody remembered those economists who had believed in it in the past.

That’s quite the dare, and I recommend that you do not take that dare, because Mises was already writing about it in 1941 in “Human Action”, pg 468-9, Rothbard was already writing about it in the 1960s in “Man, Economy and State”, pg 536, and before that, Hayek wrote about it in the early 1930s in “The Paradox of Saving”, pg 214.

You were late to the party if you started in the 1980s, but it’s still good that you recognized it. Most economists don’t. However it’s simply absurd to say “nobody” believed in it and “nobody remembered” it. Austrians NEVER forgot “good deflation.” Every major Austrian writer has written about it.

Sorry to burst your desired claim to fame, but like that expression goes, what’s good is typically unoriginal, and what’s original typically isn’t good.

Well, I was working too fast and screwed up part of the interpretation of the charts. These are revised to be in terms of percentage of GDP, which makes things clearer. It was disturbing to see net worth and GDP part company. Now they only do starting with the Greenspan era (what a surprise). The excursion is still around %100 of GDP.

BTW, Scott, with regard to your 1987 comparison, I’ve magnified things in the last chart to make 1987 visible. It’s a 6% drop in total financial assets.

Net worth was constant as percentage of GDP until the 1990s, when it rose 20 % for the dot com boom, fell back most the way around 2002, the climbed to up 30% and crashed back to trend, EXCEPT, because I’ve plotted everything as a percentage of GDP and GDP fell, so in reality all the gain was erased and a few percent more.

There’s nothing like this post 1949. I’d love to see 1920-1940, most FRED data goes back only to 1949.

What I’d REALLY like is to do the same sort of calculation on some of the euro countries. You’d have to include loss of government benefits, though or it wouldn’t be comparable.

If you do this, I’ll bet that the numbers are much worse – higher boom, bigger bust.

“When people buy fewer Fords, the the relative profitability of other car companies rises …”

Yes.

“… and the relative profitability of capital goods in general rises.”

No.

No, that’s a yes as well. When you spend less on consumption, and accumulate cash, then the profitability of consumer goods falls, correct? Well, if consumer goods profitability falls, then the RELATIVE profitability of capital goods rises. You can’t assume that any fall in consumption spending is the same thing as a fall in capital goods spending. You spending less on Fords is not the same thing as capital goods investors spending less on capital goods. This is a myth that MUST die already. It leads the mistaken belief that consumption spending finances the entire economic structure, when in reality it is saving and investment that supports it, and not only that, but saving actually finances most “spending”, including consumer spending (through wage payments), in the economy.

If you admit that the relative profitability of other car companies rises when people buy fewer Fords, then you understand that a fall in spending in one location is not the same thing as a fall in spending in other locations.

“Remember, a fall in spending on Fords reduces the profitability of Fords, and that increases the relative profitability of everything else not Fords.”

Go back to the circular flow of income.

I reject the circular flow of income doctrine. I adhere to that which resembles Hayek’s triangle.

Households are spending on consumer goods. Spending on consumer goods becomes revenue to the firms that make them. These revenues are spent on firm inputs.

No, you have it backwards. This is exactly why the circular flow leads to confusion. You start at the end, and because in the circular flow doctrine the end touches the beginning, it leads to the fallacious notion that the end finances the beginning. No.

If households are spending on consumer goods, then THAT PRESUPPOSES a prior saving and abstaining from consuming, in order to finance and produce that which is now demanded by households. Production doesn’t start with consumer demand. A million people on a deserted island with $100 million each, where they all yell at each other “I am willing to buy consumer goods!” doesn’t mean that there is production ready for them to buy.

No, someone has to ABSTAIN from consuming, and save and invest in some production process FIRST, and THEN over time, after the goods are produced, can any consumer buy a good.

When you buy a Ford, you’re not financing the production of Fords. Ford’s owners already financed the production of Fords in the past, through abstaining from consuming, and saving and investing instead, and now they’re hoping you’ll buy a Ford.

Yes, AFTER Ford already saved and invested in the production of Fords, they then use your consumer revenues to continue production going forward, but even then, the revenues they earn still have to be saved and invested, and they cannot be consumed by Ford’s owners.

If everyone took their revenues and spent 100% of them on their own consumption, then the demand for capital goods and labor would collapse, and production would collapse. Virtually every consumer good that is currently produced would eventually disappear because nobody is saving and investing, and everyone is just spending money on consumption.

Now, it’s common for people to believe that because a single firm depends on its own customers for revenues, for the business to stay in operation, that somehow this is also true in the aggregate, where in the aggregate, consumers make business production possible. This is the fallacy of composition. Consumers are not financing the entire structure of production. They are choosing among alternative ends of consumer goods. In the aggregate, consumers are completely dependent on producers, not the other way around. Consumers as a group depend on producers as a group to save and invest and produce what their money can buy. If there are no producers, then consumers will be left empty handed. If there are no consumers, then producers will simply consume their own products as in an early and rude state of society a la Adam Smith. Producers can depend on themselves if they want to consume. Consumers depend on producers if they want to consume.

(Actually, the inputs were already mostly paid for by borrowing, and the revenues now largely cover debts and interest.) The input producers include households supplying labor, and firms supplying capital goods and other intermediate goods. The spending on labor services becomes income to the households that supply them. The spending on the firms becomes revenue, which pays for their inputs, which include labor and capital goods… until eventually all spending is received as income by households. And then those households spend again, which continues until the circular flow ends as all dollars are held. Of course dollars that are held are also spent eventually, which begins the next circular flow.

In my conception, the start is saving and investment, and then there is production, and then the end is consumption. Then a fresh new saving and investment is made, and a fresh new production, and another new end of consumption is had. And so on. Time always goes forward. Human action is goal oriented. There is no turning back. There is no circularity to economic life. If there is too much consumption spending and not enough capital goods and labor spending, then going forward, people will forever be deprived of the future that could have been had if there was more saving and investment and less consumption spending in the past.

Just because the nominal money flows go back and forth between individuals, from investor to wage earner, and from wage earner back to investor, giving the illusion of “circularity”, it doesn’t mean that there is progress being made, or that a fall in consumer spending “breaks” the circularity and makes everyone worse off.

Now, what happens when people buy less Fords? Let’s assume the price level doesn’t adjust.

Why on Earth would you do that?

Output of the Ford Motor Co. falls, of course. But so does the output of the suppliers of labor and capital goods to Ford. So workers are unemployed at Ford. But also, the workers at the firms supplying to Ford are unemployed. But also, the workers at the firms supplying to the firms that supply to Ford are unemployed. And all the households in this line of spending receive less income. Meanwhile, first-round spending on other consumer goods continues unabated. So does spending on all their inputs. So the income from that line of spending still reaches households. But with the price level stuck, the input providers not being paid by the Ford line of spending are not paid by anyone else. So aggregate nominal income to households falls. So aggregate real income to households falls. So the next round of spending on all consumer goods is lower. So the next round of all spending on all capital goods is lower. So the next round of income to households is lower. And so on.

This is the myth I call consumptionism. It is the myth that the entire economic structure is supported by consumer spending, and that falling consumer spending generates depressions, unemployment, etc.

To address your analysis:

Yes, if there is a fall in spending on Fords, then Ford will then reduce its spending on factor inputs. But this doesn’t mean unemployment, because I don’t assume absolutely rigid prices like you are assuming. I assume flexible prices. I assume flexible prices because the context in which I make this argument is a market economy, not a planned economy, or an economy with government controls that prevent prices from being flexible.

Now, what if prices were flexible? In that case, spending on Fords falls. And Ford still spends less on its inputs. The workers at its factories will be unemployed, though reemployed elsewhere if they accept lower wages.

That isn’t true either. If you assume flexible prices, then Ford supplier wage rates can fall. They don’t have to find employment elsewhere.

We assumed that people have lowered their real demand for Fords; i.e. they want to hold money balances instead of Fords at any price of Fords. So Ford suffers. But the providers of intermediate goods to Ford (materials and capital) can still sell all their output, by lowering their prices. In this way, surplus resources are absorbed into the rest of the economy. Meanwhile, spending on other consumer goods continues unabated, as does spending on the corresponding producer goods. But because producer goods are cheaper (since prices were flexible), the firms producing all the other consumer goods buy the surplus of producer goods, and there is no more unemployment. Eventually, all the spending is received by households. Because the households buying Fords spent less, the aggregate quantity of dollars received by households in the first round of spending falls. So nominal income falls. But because prices are flexible, all producers of the next rounf of consumer and capital goods being spent on can lower their prices slightly, to absorb all the demand. If nominal income from the first round falls by 0.1%, then spending on all goods falls by 0.1%. But if the price level also falls by 0.1%, then real income stays constant. The budget constraint of households shifts out by as much as it shifts in, with no change in the slope. So the composition of the second round of spending is exactly the same as it would have been. This is not surprising: If the govt. announced that each coin would be worth half its face value, you’d expect prices to fall in half, and everyone to buy the exact same things, wouldn’t you? Only the numbers on the value of the transactions have changed. But “relative spending” does not change. Ford drops out of the first round of consumer good producers. And the lower revenue of first round consumer good producers is now shared among the same number of producer good producers, so the revenues of these firms is lower. But “relative profitability” shifts slightly in favor of consumer goods, not producer goods. This higher relative profitability will eventually induce the entry of a new consumer goods provider to replace Ford.

You’re ignoring one major thing, and it is due to you focusing too much on money flows, and not enough on the REAL effects.

Assuming flexible prices, it is the case that when the demand for consumer goods falls, it does two things.

One, it makes the relative prices of consumer goods (versus capital goods) fall. A fall in the price of a Ford of say 10%, will have a series of smaller falls in prices for all the many factor of production that go into Fords. It won’t be the case that steel suppliers, plastics suppliers, and tire suppliers all reduce their prices by 10%, for Ford represents only a portion of their total portfolios. This results in a relative price change of consumer goods (Fords) and capital goods (Ford suppliers). When relative prices change, so will investment. Investment will be redirected towards capital goods and away from consumer goods. That makes the economy more capital intensive, and thus will result in falling prices beyond that generated by the higher purchasing power of money. In other words, an increased cash holding by consumers operates side by side with capital accumulation. It won’t decrease overall productivity. It will decrease present productivity for sure, since consumers want fewer present consumer goods. But as this takes place, the economy becomes more focused on capital goods production, and that has the long term effect of increasing productivity. So if you want to visualize it via a line on a chart, it will look like a straight upward sloping line, which then levels off and turns sharply downward, then it levels off and starts to slope upward again, but this time at a more steeper slope than before.

Two, a fall in spending on Fords will free up resources and labor from Ford, and to the extent that these resources are absorbed into capital goods industries, that makes the economy more capital intensive, and more productive, and that leads to a fall in prices beyond that which is caused by the increased purchasing power of money.

“A reduction in spending on Fords doesn’t have to be matched by an equivalent increase in nominal spending on other things, before the profitability structure changes and before relative spending changes.”

If prices are sticky, then producers of both consumer and producer goods receive less spending and profits relative to others. If they are flexible, then relative spending does not change between producer and consumer goods (at all), or between producer goods and other producer goods (very much; obviously other companies will buy producer goods in different proportions than Ford did, so some prices will fall more than others).

This is false. If prices are flexible, then relative spending does change. This is because with lower demand for consumer goods, and higher cash balances, it FREES UP resources and labor from consumer goods industries. When those resources are reabsorbed, it is guaranteed that relative prices change, because that is the very mechanism by which those resources are reabsorbed.

Sure, but the nominal spending isn’t changing for other consumer goods producers, and so there is no change in their revenues. The only way it can affect other consumer goods producers would be to the extent that their factor costs change. But if their revenues don’t change, then they can’t spend more on costs. They can pay lower prices for more factors, sure, but they cannot increase their money demand for more factors.

If they do pay lower prices, then relative prices will change for the reasons above regarding the 10% example.

As for profitability, the profits from consumer goods are now split amongst fewer consumer goods firms, whilst the profits from producer goods are split amongst the same firms. Each consumer goods firm makes more profits, whilst producer goods firms make the same real profits on average. So although the ratio of consumer goods profits to producer goods profits stays the same, consumer goods firms are relatively more profitable than producer goods firms.

This is also false. The profitability in consumer goods is NOT the same. We stipulated that the demand for and hence profitability of, Ford cars decreases. When that happens, Ford’s decreased profitability pulls down the profitability of consumer goods. It doesn’t increase it.

“Prices do adjust, if you only stopped treating price changes as having to adjust instantaneously …”

No, they can take several years.

Wage earners won’t wait several years in the absence of welfare, union power, and mandatory price floors.

“… output and employment do not depend on “aggregate demand”. They both depends on saving and investment.”

Neither of which increases in real terms to compensate the fall in real consumption.

But they do increase in real terms, as shown above.

Indeed both saving and investment fall as soon as the markets anticipate recession.

Sure, they might fall, but the long term result is a more capital intensive economy. When resources are freed up from consumer goods production, at some point they will be reabsorbed by capital goods producers. They will go to where there is demand for them, and eventually prices will adjust.

“If consumer spending falls, then investors will reprice factors of production to be lower … “

No they won’t, because prices (particularly wages) are sticky downwards.

Yes, they will, because prices, while they may be sticky, are not absolutely rigid, in a market economy.

Prices become more sticky in an inflationary economy that has central banks trying to “stabilize” prices and/or spending. It gets people used to expecting rising prices, which makes prices more sticky. Inflation cannot possibly be a solution to any sticky downward prices. It would be like recommending more alcohol to stop a hang over.

“… why can’t Ford simply reduce their demand for factors of production? The price level doesn’t have to fall by 0.1%. Ford can just spend less on resources and labor, and those resources and labor can be absorbed elsewhere in the economy, …”

That’s exactly what they will do. And what happens when the demand curve shifts to the left, whilst the supply curve doesn’t?

You are ignoring the freed up resources. They don’t disappear from the economy.

That’s right, equilibrium price falls. But if the actual price level doesn’t fall to equilibrium, there will be surplus resources which won’t be absorbed elsewhere.

Who do you know will choose starve versus work for lower wage?

“… exactly like you presume is the case when aggregate demand stays the same and there is a reduction in demand for some goods and an increase in demand for other goods. The companies that experience a drop in demand will release resources and labor for other companies to purchase.”

See the difference in this case? The demand curves of some buyers shift left whilst other demand curves shift right by the same total amount, so the price doesn’t fall.

So what? It’s not necessary or that prices don’t fall elsewhere.

Yes of course when demand falls this “releases resources”, that’s what unemployment is all about. But the “other companies to purchase” doesn’t happen on its own, because by assumption markets were in equilibrium beforehand (markets were clearing beforehand), and everyone was already buying all they wanted to buy at the given prices.

There is no such thing as equilibrium in effect. There is only a tendency towards it. You can’t presume equilibrium before. Before, there was a tendency, just like there is one right now.

The surplus resources can be absorbed, but only if prices fall. The perfect free-market economy which your Austrian theory tries to describe presumes flexible prices for everything, including labor. In that case you would be right, the economy adjusts to all changes in individual decisions on its own. But free-market economists have always realised (including Fisher and Friedman) that that is an empirically unrealistic assumption. Hence aggregate spending matters, particularly on the downside.

How can people make prices more flexible, if there is a money printer who always ensures that prices don’t fall, or that spending doesn’t fall?

If you want to get prices to be more flexible, the LAST thing one should recommend is anything that makes people less willing to lower their prices, such as forcing them to produce and live in an inflationary economy.

I am not assuming perfectly, instantaneously flexible prices. No Austrian presumes it either. This is the mother of all straw man that inflationists set up when they try to address Austrian criticisms of inflation.

Austrians hold that infinitely flexibly prices would turn the economy into a choatic mess that would make economic calculation impossible. Prices requires some rigidity in order to serve as tools of human planning, which takes time. Humans aren’t infinitely speedy Gods who can instantly absorb price changes across the economy. If prices did change according to every minute change in supply and demand everywhere, then the price system would in fact break down.

SOME price stickiness is therefore a GOOD thing. Some price stickiness is NOT, contrary to monetarists and other inflationists, an open invitation by Austrians for the Fed to print money for themselves and their friends, thus making prices more inflexible downward.

During the 1920 depression, wage rates fell 20% on average. This was because people were still psychologically used to price deflation. Their parents and their grand parents lived during times where consumer prices gradually fell. Of course the fall in wage rates was not complete, and had more to go, but before the market could do so, the Fed was already inflating starting in 1922 or so, which prevented prices from falling further, and making some monetarists believe the fallacy that 1920 is somehow a time that represents a textbook example of price stickiness that justifies inflation.

Of course, I have ignored the fact that not every drop in aggregate spending is recessionary. Firms are not stupid; they prepare for fluctuations in nominal spending. They produce at the average level of output demanded, known misleadingly as “potential output”. So when there is less demand in one year, firms accumulate inventories, expecting to sell more in the next. Only when there is a massive accumulation of inventories and a clear decline in consumer confidence (again, if the price level were flexible no one would care about “consumer confidence”) do firms start laying off workers.

THIS is the part of your post that actually underlies my own conviction of what happens. I agree that firms aren’t stupid and anticipate fluctuations in nominal spending. But here’s the crucial aspect about that: If consumer goods firms respond by accumulating inventory, expecting that future consumer goods sales will rise, then you have completely conceded my point about relative demand and relative price changes. You also conceded my point that capital goods spending doesn’t necessarily fall with every fall in consumer goods spending. Ford can accumulate inventory, pay the same prices, spend the same on factors, and accept a current fall in consumer spending, in anticipation of higher future sales, like me buying a Ford after saving up cash.

I think it will help you to keep the simple AS/AD model (levels, not growth rates) in mind as you think about these questions. Treat it as a metaphor if you like, but it really clarifies your thinking.

I find AS/AD model as too vague and not detailed enough to explain the market process. It can only help with basic questions, but I think it will help you to cease using the circular flow of income doctrine, cease believing that inflation is a solution to price stickiness, and focus more on the market processes involved, of relative prices and demands.

Here are some passages of “good deflation” from the sources I listed above:

“If the quantity of money remains unchanged, the unavoidable fall in the relative prices of consumption goods will also manifest itself absolutely. It is in this way that the relative fail will establish itself at the moment when the new consumption goods come on to the market. If the supply of money is kept constant, this effect of every extension of production will be well known to producers and they will therefore only choose such employments for the investment of new savings as remain profitable even if prices are expected to fall. But these employments-and this, as we shall see presently, is the essential point-are the only ones through which the social advantages of saving catn be realised without loss.” – Hayek, Paradox of Saving, 1931, Economica, pg 150.

“Every attempt to prevent the fall of prices by increasing the volume of money will have the effect of increasing production to an extent that it is impossible to maintain, and thus part of the savings will be wasted.” – ibid, pg 156.

—

“Suppose, for example, that the purchasing power of money rises and that we disregard the problem of measuring the rise. Why, if this is the result of action on an unhampered market, should we consider it a bad result? If the total supply of money in the community has remained constant, falling prices will be caused by a general increase in the demand for money or by an increase in the supply of goods as a result of increased productivity. An increased demand for money stems from the free choice of individuals, say, in the expectation of a more troubled future or of future price declines. Stabilization would deprive people of the chance to increase their real cash holdings and the real value of the dollar by free, mutually agreed-upon actions. As in any other aspect of the free market, those entrepreneurs who successfully anticipate the increased demand will benefit, and those who err will lose in their speculations. But even the losses of the latter are purely the consequence of their own voluntarily assumed risks. Furthermore, falling prices resulting from increased productivity are beneficial to all and are precisely the means by which the fruits of industrial progress spread on the free market. Any interference with falling prices blocks the spread of the fruits of an advancing economy; and then real wages could increase only in particular industries, and not, as on the free market, over the economy as a whole.” – Rothbard, Man, Economy and State, 1962, pg 850.

—

“Let us think of a world in which the quantity of money is rigid. At an early stage of history the inhabitants of this world have produced the whole quantity of the commodity employed for the monetary service which can possibly be produced. A further increase in the quantity of money is out of the question. Fiduciary media are unknown. All money-substitutes””the subsidiary coins included””are money-certificates. On these assumptions the intensification of the division of labor, the evolution from the economic self-sufficiency of households, villages, districts, and countries to the world-embracing market system of the nineteenth century, the progressive accumulation of capital, and the improvement of technological methods of production would have resulted in a continuous trend toward falling prices. Would such a rise in the purchasing power of the monetary unit have stopped the evolution of capitalism?

“The average businessman will answer this question in the affirmative. Living and acting in an environment in which a slow but continuous fall in the monetary unit’s purchasing power is deemed normal, necessary, and
beneficial, he simply cannot comprehend a different state of affairs. He associates the notions of rising prices and profits on the one hand and of falling prices and losses on the other. The fact that there are bear operations too and that great fortunes have been made by bears does not shake his dogmatism. These are, he says, merely speculative transactions of people eager to profit from the fall in the prices of goods already produced and available. Creative innovations, new investments, and the application of improved technological methods require the inducement brought about by the expectation of price rises. Economic progress is possible only in a world of rising prices.

“This opinion is untenable. In a world of a rising purchasing power of the monetary unit everybody’s mode of thinking would have adjusted itself to this state of affairs, just as in our actual world it has adjusted itself to a falling purchasing power of the monetary unit. Today everybody is prepared to consider a rise in his nominal or monetary income as an improvement of his material well-being. People’s attention is directed more toward the rise in nominal wage rates and the money equivalent of wealth than to the increase in the supply of commodities. In a world of rising purchasing power for the monetary unit they would concern themselves more with the fall in living costs. This would bring into clearer relief the fact that economic progress consists primarily in making the amenities of life more easily accessible.” – Mises, Human Action, 1949, pgs 468-9.

And finally, one for market monetarists:

“In the conduct of business, reflections concerning the secular trend of prices do not bother any role whatever. Entrepreneurs and investors do not bother about secular trends. What guides their actions is their opinion about the movement of prices in the coming weeks, months. or at most years. They do not heed the general movement of all prices. What matters for them is the existence of discrepancies between the prices of the complementary factors of production and the anticipated prices of the products. No businessman embarks upon a definite production project because he believes that the prices, i.e., the prices of all goods and services, will rise. He engages himself if he believes that he can profit from a difference between the prices of goods of various orders. In a world with a secular tendency toward falling prices, such opportunities for earning profit will appear in the same way in which they appear in a world with a secular trend toward rising prices. The expectation of a general progressive upward movement of all prices does not bring about intensified production and improvement in well-being. It results in the “flight to real values,” in the crack-up boom and the complete breakdown of the monetary system.” – ibid, pg 469.

Please note that the “crack up boom” is the inevitable result of fiat money inflation, and so it is no argument against this to say “It hasn’t happened here yet you sky is falling scare mongers!”, any more than it wouldn’t be an argument against someone who says the driver of a bus is heading for cliff that “It hasn’t happened yet you sky is falling scare mongers!” This argument is a LONG term argument. Consider it as a long term understanding akin to understanding how the ancient Greek empire collapsed. Any historian of today who transported back to a given year during that time, who then started to explain how the empire will collapse, is also going to be met with jeers of “We’ve been doing this for centuries! How in the world can it collapse?”

***** The real estate bust meant that some $10-$20 TRILLION in “wealth” disappeared — from the individual & corporate wealth accounts. This means the calculations of lifetime consumption savings were invalidated.

This wealth destruction especially occurred among recent homebuyers/ refinancing folk who had been increasing their consumption based on increasing house equity wealth.

Most of your points, as well as your holy grail NGDP targeting, utterly fail to appreciate the huge adjustments, changed buying decisions, the couple hundred million homeowners started making based on their houses no longer increasing in value; and then, more radical, when their houses / wealth started going down in value.

hard to believe that the opposition of conservatives to monetary stimulus is unrelated to Obama being president. Inflation was higher under Bush, and yet the intensity of conservative Fed bashing was far less.
Well, when you stop talking about theoretical inflation, and start talking about: food & gas prices, you find out that food and gas prices were NOT rising as a percentage of disposable income under Bush like they are under Obama, and it is your elitist “inflation excluding what people mostly buy” which is causing your mistake.

*** If you ever want to relate real inflation to real politics, you HAVE to include real food prices and real gas prices, because those are variables voters really see and notice, as well as their own salary changes. Too bad it’s messy and confusing and sometimes, often, conflicting with elitist models. (Since most folks don’t have “models”, all models are elitist.) This model-simplification post is sort of about this problem.

[I personally think Palin & conservatives are wrong to oppose inflation/ higher gas & food prices at this point, but to misrepresent their food & gas price argument is not fully honest– and the wealth issue means I think there could be a LOT of monetary stimulus before much inflation.]

*The Fiscal Stimulus of active gov’t spending is heavily opposed by conservatives–where less wasteful gov’t stimulus of tax cuts is much less opposed (often even supported). Conservatives are far more opposed to wasteful Big Gov’t boondoggles like Solyndra and bailouts to the rich banksters who speculated and lost and now get gov’t cash. To bring in political opposition to active monetary policy without including multiple demonstrated gov’t failures is a biased simplification.

*Demographics — post WW II has been dominated by the post war reconstruction and then the baby boomers, all pointing towards higher growth and investment in growth.
The shape of the 2001 recovery is the first post WW II recovery where baby boomer retirement means more consumption and less growth. That fewer-jobs recovery has been even more pronounced in the 2009? near-recovery.
Past history since WW II is NOT a good guide for today and the future in the USA; and it increases the uncertainty about any model / guide as to policy, especially with respect to “potential output”.

Conclusion — the FED should do more monetary easing, either with a higher inflation target or NGDP targeting (perhaps politically easier!). BUT, it’s not going to work as well as desired because of the important *’d points which don’t fit in to simplified models well.

PeterN, This was a very, very, ordinary severe recession—caused by tight money, just like the other severe recessions. As a side effect they reduce wealth, as you’d expect.

MF, You said;

“That’s funny, considering how I have corrected so many incorrect claims concerning NGDP.”

Now that’s funny, coming from someone who just showed he doesn’t even know that NGDP can be calculated independently of P and Y.

Tom, You said;

“Hi Scott, listing 10 things is great “” but I’m pretty sure you missed the biggest point.
***** The real estate bust meant that some $10-$20 TRILLION in “wealth” disappeared “” from the individual & corporate wealth accounts. This means the calculations of lifetime consumption savings were invalidated.”

This would not cause people to work less, which is the problem I am addressing. Indeed poverty makes people want to work more. And I don’t think there is any such thing as “lifetime consumption savings.” Since we invested too much in housing, the rational response would have been to raise business investment, exports, and maybe even consumption.

Mark, It is very much influenced. Higher expected NGDP growth leads to higher long term rates.

It all comes down to interest on reserves (IOR). Specifically, it comes down to paying IOR at a rate higher than the Treasury yield curve, thus blowing up the money multiplier, which is a vital link in the system that converts monetary base into NGDP. IOR is the only completely new factor. It lines up in time with the crash of NGDP growth.

IOR is the problem. Eliminate IOR, and the Fed can once again control NGDP. The McCollum rule comes back.

[…] conservatives tend to like simple answers to everything: “Just cut taxes!” or “It all boils down to X.” (Scott Sumner deserves unlimited praise for acknowledging and battling that predilection in […]

[…] conservatives tend to like simple answers to everything: “Just cut taxes!” or “It all boils down to X.” (Scott Sumner deserves unlimited praise for acknowledging and battling that predilection in […]

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.